Auditing: Audit Evidence - External Confirmations, Accounts Receivable, Bank, Legal, Vendor

? What this actually is

External confirmations are a critical part of the audit process where auditors send requests to third parties to verify the accuracy and completeness of a company's financial records. This includes confirmations for accounts receivable, bank balances, legal matters, and vendor statements. It matters because it provides independent evidence that supports the reliability of financial statements, reducing the risk of material misstatements.

? The core logic (or formula)

1. Accounts Receivable Confirmations:
2. Purpose: Verify the existence and valuation of accounts receivable.

3. Process: Send confirmation letters to customers asking them to confirm the amount owed.

4. Bank Confirmations:

5. Purpose: Verify cash balances and any outstanding loans or lines of credit.

6. Process: Request confirmation from the bank regarding the company's balances and any related transactions.

7. Legal Confirmations:

8. Purpose: Identify any legal contingencies or pending litigation that could impact the financial statements.

9. Process: Send requests to the company's legal counsel to confirm any ongoing legal matters.

10. Vendor Confirmations:

11. Purpose: Verify the existence and valuation of accounts payable.
12. Process: Send confirmation letters to suppliers asking them to confirm the amount owed.

? Hidden rule nobody explains

In practice, auditors often use a combination of positive and negative confirmations. Positive confirmations require the recipient to respond, while negative confirmations ask the recipient to respond only if there is a discrepancy. Negative confirmations are less reliable but can be more efficient for large volumes of low-risk accounts.

? Practical example / breakdown

Let's walk through an example of an accounts receivable confirmation:

1. Client: ABC Corporation has an accounts receivable balance of $500,000.
2. Auditor Action: The auditor selects a sample of 50 customer accounts totaling $200,000.
3. Confirmation Request: The auditor sends confirmation letters to these 50 customers asking them to confirm the amount owed to ABC Corporation.
4. Response: Out of the 50 letters sent, 45 customers respond confirming the amounts.
5. Analysis: The auditor reviews the responses and finds that 40 customers confirm the exact amount, while 5 customers report discrepancies totaling $10,000.
6. Follow-Up: The auditor investigates the discrepancies and adjusts the accounts receivable balance accordingly.

? Your move today

Goal: Practice sending and analyzing confirmation letters.

Step-by-step:
1. Open a word processor and create a template for an accounts receivable confirmation letter.
2. List 10 hypothetical customer accounts with varying amounts.
3. Draft and send (hypothetically) confirmation letters to these customers.
4. Simulate responses from these customers, including a few with discrepancies.
5. Analyze the responses and determine the impact on the accounts receivable balance.

What to save: A completed template of the confirmation letter and a summary of your analysis.

? Quick reference asset

External Confirmations Cheat Sheet

Sample Accounts Receivable Confirmation Letter:

[Date]
[Customer Name]
[Customer Address]

Dear [Customer Name],

We are conducting our annual audit of ABC Corporation's financial statements. As part of this process, we are verifying the amounts owed to ABC Corporation by its customers.

Please confirm the amount owed to ABC Corporation as of [Date] is $X,XXX.

Thank you for your cooperation.

Sincerely,
[Auditor's Name]
[Auditor's Contact Information]

Common mistakes & recovery

• Common Error 1: Not following up on non-responses.
• Recovery: Always follow up with customers who do not respond to confirmation requests.
• Common Error 2: Ignoring discrepancies.
• Recovery: Investigate and resolve any discrepancies found in the confirmation process.
• Quick Check: Ensure that all confirmation responses are documented and reviewed.
• Exam Tip: Prioritize understanding the purpose and process of each type of confirmation to quickly identify the correct approach under time pressure.

? Completion check

I can draft and analyze external confirmation letters for accounts receivable, bank, legal, and vendor statements, and understand their role in the audit process.